Bulls Often Hit Wall In Fourth Year Of Rally

CHET CURRIER Fund Watch

Ready or not, the mid-'00s recovery in stock prices is about to be tested for stamina.

The rally of the last three years has given a decent, if not quite spectacular, performance. Now comes time to separate the bulls from the calves, in both stocks and stock mutual funds.

Year Four, recent market history tells us, presents a tough hurdle for any up-and-coming bull market. After three years, the elementary cyclical forces that inspired reflexive recoveries from market declines may be pretty well depleted.

That puts the market in a prime position to demonstrate in 2006 whether something more solid and durable is going on.

With price advances of 26.4 percent in 2003, 9 percent in '04, and 3 percent in '05, the Standard & Poor's 500 Index strung together three consecutive gains after a decline for the ninth time since World War II.

According to my Bloomberg, five of the previous eight failed to carry over through a fourth year. All eight in the aggregate produced a paltry net gain for Year Four of 1.1 percent.

The Year Four curse hit the market with a 14.3 percent decline in 1957, a 13.1 percent loss in 1966; 17.4 percent in 1973, and 9.7 percent in 1981.

Happily for the bulls, the pattern improved after that. Following consecutive gains in 1982-84, the S&P 500 climbed another 26.3 percent in 1985 -- and for good measure went on to put up plus signs for another four consecutive years.

After advancing in 1991-93, the index sustained a relatively mild 1.5 percent setback in 1994 before surging ahead again. Following gains in 1995-97, it climbed 26.7 percent in 1998 and added a fifth year to the winning streak in 1999.

So a 50-year retrospective invites two possible interpretations -- one that raises pleasant prospects for the year just now beginning, and one that doesn't. In the light of these two perspectives, 2006 presents itself as a showdown year in a long-running argument between bulls and bears.

Let's take the negative view first. This holds that through the 1980s and '90s stocks dwelt in a land of make-believe where normal cyclical forces were suspended, making it possible for bull markets to continue beyond all reasonable bounds.

That bubble has since burst, and the old, grinding market cycle is back in force. Good times by their very nature produce excesses that lead inevitably to periods of retrenchment. When a bull market gets to its fourth year, its staying power is highly suspect.

Now for the bullish argument: As the 1980s and '90s arrived, Federal Reserve policy-makers showed that they had learned some important lessons from mistakes made earlier in the century. They got skillful enough at managing the ups and downs of inflation, interest rates and other variables to smooth out the economy's progress.

They even had some help from Wall Street. In the housing cycle, for instance, periods of "tight money" were no longer necessary. Bank deregulation and the securitization of mortgages helped assure that ample credit was always available for home buyers, whether interest rates happened to be high or low at any given moment.

While all this was happening, technological innovations such as the Internet ushered in a new age of accelerated productivity and global growth.

This brought a lasting change. The game is never going back to the way it was played in the 1960s and '70s. A bull market in its fourth year can still be full of youthful vitality.

Given a choice between the two, I'll go with that second view. But I acknowledge that congenital optimism, which may rest at least as much on emotion as it does on reason, may not impress every skeptic with its argumentative force.

To get a substantive ruling on which side is correct, there is probably no better place to look than the market itself. And what better time to consult it than the fourth year of a bull market? Between now and the end of 2006, we may learn all sorts of interesting things.

Chet Currier is a Bloomberg News columnist. He can be reached at ccurrier@bloomberg.net.